Investment Strategy
We seek to pick winning funds with superior management and quantitative characteristics linked to strong performance. Our quantitative research uses the most comprehensive mutual fund database in the world to determine the best strategies for long-term investing success. We then supplement those studies with extensive qualitative research of portfolio managers, analysts, and traders through onsite visits and follow-up phone calls.
 
About the Editor
Russel Kinnel is director of manager research for Morningstar, Inc. and editor of Morningstar FundInvestor, a monthly print newsletter for individual investors. He also writes the Fund Spy column for Morningstar.com, the company's investment Web site.

Since joining the company in 1994, Kinnel has covered the Fidelity, Janus, T. Rowe Price, and Vanguard mutual fund families. He helped develop the new Morningstar Rating for funds and the new Morningstar Style Box methodology. He also is co-author of the company's first book, The Morningstar Guide to Mutual Funds: 5-Star Strategies for Success, which was published in January 2003.

 
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About Russel Russ' Photo
Russel Kinnel,
Director of Manager Research and Editor, Morningstar FundInvestor
Russel Kinnel is director of manager research for Morningstar, Inc. and editor of Morningstar FundInvestor, a monthly print newsletter for individual investors.
Featured Posts
We Have Downgraded 3 Funds

Sorry to be a downer on a Monday, but we downgraded three funds: Loomis Sayles Bond LSBDX, Fidelity Emerging Markets FEMKX, and DFA International Small Cap Value DISVX. At least two of those three are still Morningstar Medalists, anyway. Here’s our take:

Loomis Sayles Bond by Sarah Bush
Loomis Sayles Bond's deep and seasoned team, contrarian strategy, and solid long-term returns count in its favor. That said, modest concerns surrounding the fund's equity stake support a downgrade of its Morningstar Analyst Rating to Silver.

Long known for its founder Dan Fuss' benchmark-agnostic approach to investing, this experienced team doesn't shy away from risk. Over time, sizable allocations to non-U.S.-dollar-denominated bonds and a large corporate stake, including junk-rated fare, have dominated the portfolio. At the same time, the portfolio's typically mid-single-digit common stock stake distinguishes it from the majority of its multisector bond Morningstar Category peers, while concentration in this stake adds idiosyncratic risk. For example, in late 2016 the portfolio's combined position in Intel INTC stock and an equity-sensitive convertible topped 8%. The team eventually sold that name but bought a 3% position in AT&T T common stock in late 2018's volatile markets, part of a 7% allocation to equities at year-end. The team cited that company's generous free cash flows, strong competitive position, and plump yield.

The fund's aggressive and often contrarian approach has translated into a bumpy ride for investors. For example, while the team had turned somewhat cautious on credit as of mid-2014, the strategy still suffered disproportionately in the commodity-led sell-off that started later that year. For the most part, however, the team has used such periods of market stress to its advantage. In late 2014 and 2015, for example, the team quickly added to battered high-yield names, especially in the energy sector, that it thought most likely to survive. That positioning helped the fund to a strong rebound in 2016 and 2017.

Over the long haul, the team's eye for value has helped it to returns that handily beat most of its competitors over the long haul. The fund's 6.2% annualized gain during the trailing 15 years ended February 2019 topped 80% of its distinct peers. For those with the requisite patience, it remains a strong choice.

Fidelity Emerging Markets by Gregg Wolper
The impending manager change at Fidelity Emerging Markets will have a substantial impact on the fund in ways that are as yet not clear. Its Morningstar Analyst Rating has been downgraded to Neutral.

On Feb. 22, 2019, Fidelity announced that effective Oct. 1, 2019, manager Sammy Simnegar will step down from this fund. (He has been tapped to take over Fidelity Magellan FMAGX at the end of 2019 and has already been named a comanager there.) Also on Feb. 22, John Dance became comanager of the retail version of this fund. He will become sole manager on Oct. 1. (The Advisor version of this fund, which had been run by Simnegar in an identical manner, will get a different successor using a different approach.)

The management shift will inevitably lead to some changes on this fund. Simnegar’s style is unique. If he likes a stock in the MSCI Emerging Markets Index, he’ll own it at 50 basis points (0.5 percentage point) over its index weighting. If he doesn’t like it, he won’t own it at all, except for two or three very big index names. He rebalances weekly to maintain those weightings. Dance, who currently manages Fidelity Emerging Asia FSEAN and Fidelity Pacific Basin FPBFX, owns some of the same holdings, but there are many differences between the funds besides Simnegar’s much broader universe. For example, Simnegar will hold stocks domiciled in the U.S.; those made up roughly 10% of the Dec. 31, 2018, portfolio, while Fidelity Emerging Asia had nothing there. Ping An Insurance made the top 10 of Simnegar’s portfolio, with 1.7% of assets; Dance didn’t own it at all. Fidelity Emerging Asia has less than half the turnover rate of Simnegar's fund.

Dance has a sound record at Emerging Asia, which has a Morningstar Analyst Rating of Bronze, but has only run it for about two years. His 5.5-year record at Pacific Basin (no Morningstar Analyst Rating), is also impressive, but half of that portfolio is in Japan and Australia. In short, Fidelity Emerging Markets’ retail version will be getting a good manager, but one with a somewhat different style who hasn’t run a broad emerging-markets fund.

DFA International Small-Cap Value by Daniel Sotiroff
DFA International Small Value Portfolio follows a solid strategy that aggressively pursues small stocks trading at lower valuations. But its expense ratio is less competitive with its category peers that it had been historically, so its Morningstar Analyst Rating is being downgraded to Bronze from Silver.

The fund pursues small companies trading at lower relative valuations in a more aggressive way than its competitors. The managers target stocks listed in foreign developed markets that land in the smallest 12.5% of each country’s market capitalization. Potential holdings are pared down further to the cheapest 35% based on price/book ratio, DFA’s preferred valuation metric. Next, they remove stocks with poor profitability and those trading at higher relative valuations. These last two screens give the fund a slight advantage over peers by directly eliminating stocks associated with poor future performance.

The result is a portfolio that goes after small-cap stocks trading at lower valuations in a more assertive manner than many of its peers, with one of the lowest price/book ratios in the foreign small-value Morningstar Category. Venturing deep into small-value territory exposes the portfolio to stocks that can be expensive to trade. To keep transaction costs down, traders on this fund can substitute one stock for another with similar characteristics.

Deeper tilts toward smaller and cheaper stocks have helped the fund outperform over long periods of time. It was launched in December 1994 and has managed to beat the MSCI World Ex USA Small Value Index by 0.21% annually through January 2019, with mildly higher volatility. But these tilts increase risk and don’t always pay off. As an example, the fund’s strong value orientation caused it to lag its benchmark by 13 percentage points in 2009.

Funds with well-diversified portfolios, similar factor exposure, and lower fees have become more prominent in the category over the past several years. So, the fund’s relatively higher expense ratio makes it less appealing. 

 

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